March 03, 2010

Mailbag with Julia - "Why is my lender still trying to collect even after a foreclosure sale?"

When I started this blog, it was an added service for my clients, butI find that I am getting constant phone calls and emails from people who are not my clients.To be clear, I work with lenders (private money investors, mortgage pools) and do not engage in borrower or debtor work.99% of these calls and emails I receive are from borrowers who want free legal advice.I don't work like that, but I do believe in giving time and general knowledge to my community.I thought the best way to deal with this was to just start posting some of the fact patterns and my responses.

It's not intended to be legal advice, but I hope it is sufficient general education for people who have an interest.Remember -

I am not your attorney, you are not my client and no attorney-client relationship has been formed by this general discussion.

Today's question (with details removed) from Reader R.B. -

"I have a 80/20 loan on a foreclose primary residence home in California effective 2009. The first loan did a 1099c which charged off $$$k and can be excluded from as an income per Califnornia Debt forgiveness law and second loan that did NOT do a 1099 and instead tranferred the account to a collection agency with the outstanding balance of $$$k. Since its a primary residence, am i still covered by the anti-deficiency law or Federal Debt Morgage Act 2007 that will exclude me for being responsible for the 83k debt deficiency? Since they are not issuing a 1099, how will this affect my 2009 taxes and what's the best way to take care of this?"

Ok, RB - lots of wrong assumptions in this message that I am not sure even where to begin to correct. Obviously I do not have all the facts of your situation either and cannot provide a meaningful analysis.Also, I do not give tax advice, and you need a tax specialist for that.

That said, you should understand that if you have two loans, you have two lenders who could have foreclosed.If one lender foreclosed, so only one lender was “paid” by the foreclosure sale. That lender used the power of sale in the Deed of Trust (one of the two loan documents, listen to my DirtLaw Primer Podcast series for more explanation of your loan documents.) If the “sale price” at that foreclosure sale did not satisfy the loan amount, the law is still that the lender is deemed fully paid, and the deficiency is what you may receive a 1099 for.

However, the other lender is not paid and is still owed money.And, now there is no collateral for that bank to foreclose on. They are what we call a “sold-out second” or “sold-out junior lienholder.” Accordingly, that unpaid lender can sell the Promissory Note to a debt collection company.The collection agency can continue to pursue the debt on the unpaid loan.

There is no "deficiency" in this circumstance for the 2nd lender. There must be an actual sale to create the deficiency. Since the property was only sold once here, only that lender conducting the sale ended up with a deficiency between the value of the collateral and the amount of their loan. The 2nd lender ("sold-out junior lienholder") had no sale and no deficiency and therefore the borrower has no anti-deficiency defense or protection as to the sold-out second lender.

You should contact your local county bar association and ask for the Lawyer Referral Service for a

4 Comments

Hi Julia. I like your blog, but I am not sure I agree with your analysis here. I do not, however, practice real estate law, nor do I practice law in California. I just have a casual interest in these issues, and may well be missing something.

Here is how I frame the issue based on the original reader question:

First, assume that Homeowner fulfills the requirements of 580b (i.e., if the lender’s loan is (1) used to pay all or part of the purchase price of (2) a dwelling which (3) houses fewer than four families and (4) the purchaser occupies the dwelling, then the lender may not seek a deficiency judgment).

Second, assume that Homeowner has two notes: a note for 80% of the purchase price from Lender A, and a note for 20% of the purchase price from Lender B. Each lender has secured the property with a deed of trust.

Third, assume that Homeowner has defaulted on both notes. Lender A forecloses, pursues a non-judicial foreclosure sale, and winds up taking all of the proceeds from the sale to satisfy its note.

Assuming the truth of all these assumptions, Lender B now has a valid note, but the collateral under the deed of trust has evaporated. Lender B is, of course, a “sold-out junior.” May Lender B pursue a deficiency judgment against Homeowner, or is Lender B precluded from a deficiency judgment by 580b? My reading of the cases suggests that Lender B may not pursue a deficiency judgment.

In Brown v. Jensen, the California Supreme Court held that a sold-out junior was precluded from pursuing a deficiency judgment against a homeowner under 580b. 41 Cal. 2d 193, 197-98 (Cal. 1953). The Court noted that, although “the section speaks of a deficiency judgment after sale of the security” it actually means “after an actual sale or a situation where a sale would be an idle act [because] the security has been exhausted.” Id. The Court concluded by pointing out that “[t]he section states that in no event shall there be a deficiency judgment, that is, whether there is a sale under the power of sale or sale under foreclosure, or no sale because the security has become valueless or is exhausted.” Id. at 198.

A decade later, the Court again addressed the issue of a sold-out junior in Roseleaf v. Chierighino, 59 Cal. 2d 35 (Cal. 1963). In Roseleaf, the Court appeared to retreat from its holding in Brown. The Court first stated that “[t]he ‘one form of action’ rule of section 726 does not apply to a sold-out junior” because “[t]here is no reason to compel a junior lienor to go through foreclosure and sale when there is nothing left to sell.” Id. Without a security to go after, the Court reasoned, the single form of action must be to sue directly on the note. Id. The Court then declined to apply 580b, arguing that the purposes behind 580b were not fulfilled by the facts of the case. Id.

Roseleaf, however, was distinguished and clarified in Spangler v. Memel, 7 Cal. 3d 603 (Cal. 1972). In Spangler, the plaintiff argued that Roseleaf implicitly overruled Brown’s holding that that a sold-out junior was precluded from pursuing a deficiency judgment against a homeowner under 580b. The Spangler Court disagreed and, instead, reaffirmed the core holding in Brown: “580b by its language applies to a sold-out junior lienors holding a purchase money mortgage or deed of trust.” Id.

Although this is not an exhaustive survey of case law, these cases seem to stand for the proposition that a sold-out junior may not pursue a deficiency judgment against a homeowner who falls under 580b’s protections, even though the security was exhausted by the senior lienholder’s foreclosure.

Applying this rule to the facts of our hypothetical, I conclude that Homeowner is home free, and Lender B is out of luck.

As a preliminary matter, Lender B is specifically allowed, under 726, to pursue an action on the promissory note rather than an action on the now valueless security. Brown, 41 Cal.2d at 195. Lender B is not forced by 726 to pursue a foreclosure when the security has already been exhausted. Id.

That said, however, Lender B’s action on the promissory note is precluded by 580b. Brown’s holding is clear: “in no event shall there be a deficiency judgment [even where] the security has become valueless or exhausted.” Id. at 198. Under Brown, therefore, there need not be “an actual sale to create the deficiency.” The fact that Lender B had a security interest in the property is sufficient to trigger 580b’s protections.

As the Court stated in Brown, “The deficiency judgment which cannot be obtained is still a deficiency judgment even though it may consist of the whole debt because a deficiency is nothing more than the difference between the security and the debt.” Id. In this case, Lender B’s “deficiency” is one hundred percent and, it seems to me, one hundred percent uncollectable.

For someone who does not practice real estate law, you have a very solid understanding of California law in regards to "sold out junior liens". I do practice real estate law in California and while I have never actually litigated this precise issue, I believe that you are correct and that the distinction of whether the junior lienholder is able to pursue a "deficiency judgment" (I believe that it is accurately characterized as such notwithstanding the fact that only the senior ienholder foreclosed against the borrower and the junior did not)is dependent upon whether the the second obligation is a "purchase money loan" (proceeds used to purchase or improve the home)and not a HELOC or "please give me $40K to buy a boat" loan.

If I am incorrect in my analysis, I would certainly welcome anyone who could cite me specific legal authority to support such conclusion.

If you are talking about purchase money loans (which is actually pretty uncommon around here since most people have re-financed a time or two and not stated above in the fact pattern), then yes, the "piggyback" 2nd loan is also barred by the anti-deficiency statute and the case cite for that is Bargioni v. Hill 59 Cal.2d 121, 378 P.2d 593, 28 Cal.Rptr. 321, (1963).